Please Note: Blog posts are not selected, edited or screened by Seeking Alpha editors.

PayPal's Growing Pains Give Way To Bright Future

|About: PayPal Holdings, Inc. (PYPL)

Summary

PayPal shares largely unchanged since trading debut.

Integration of Venmo and Xoom to herald a new chapter of growth in the company’s legacy.

Growing revenues alongside a zero debt balance sheet add to upside potential for stock price.

Expanding user base and higher monetization to add to PayPal tailwinds.

Digital payment giant PayPal (PYPL:NASDAQ) has had a rocky start to its life as a fully independent, publicly traded entity. After spinning off from parent eBay (EBAY:NASDAQ), share prices have remained mostly flat. However, PayPal's third quarter earnings, the first released as a listed company, showed great promise. A series of investments in other companies mean PayPal could be due for a breakout year in 2016 that could see the firm boost share prices and continue to expand its market footprint. Monetization plans for digital transfer subsidiary Venmo could contribute to top-line earnings as soon as the middle of 2016. If PayPal can build on important momentum of this last year, 2016 could be a very promising year for the company's shareholders.

Solid Third Quarter

PayPal has long been a leader in the digital payment solutions sector. Founded in 1998, the company has become synonymous with easy online payments, standing as a titan of industry. In the first three quarters of 2015 alone, the company has already processed 1.22 billion transactions for a whopping $200.24 billion which puts it on pace to break 2014's $234.64 billion. On a more accessible level, this number indicates that PayPal processes over $8000 every second.

For the third quarter, the company reported on important milestones and showed continued growth in several important categories. The payment processor has been able to continue to grow its user base, adding 4 million users in the third quarter and 16 million year over year, a number that becomes more impressive as transactions per account increased by 12% compared to the previous year. The company has also reported a 15% revenue increase to $2.26 billion versus a year earlier while managing to increase its operating income to $330.00 million for the year.

PayPal managed a strong quarter and actually finished paying off its debt while still managing to increase its free cash flow both quarterly and year over year. The company ended the quarter with respectable earnings per share of $0.31, marking a 31% year over year increase.

Growth Opportunities for 2016

With the third quarter firmly in the rear-view mirror, important questions remain for PayPal heading into its first full year of being independent. For its first six months as a listed entity, PayPal stocks remained mostly in flux, seeing little real variance either way. The stock maintained a range of $30.00 to $42.55 before trending to $36.00 in July, now trading only slightly higher at $37.07.

However, there are several important factors that could play into PayPal experiencing a demonstrable rise in prices in 2016, potentially helping the company further establish itself as a digital payments leader. The first is the company's expansion within the digital payments sector from a simple payment processor into a more well-rounded service offering. PayPal has managed this by both acquiring key pieces in its segment including Xoom, Braintree and by extension Venmo. Furthermore, the firm continues to improve existing services like PayPal Credit.

Xoom, the digital money transfer company presents a growth opportunity for PayPal, as it allows the company to enter the highly profitable money transfer and remittances industry. This represents a growing segment as more workers continue to cross international borders to find employment and a means to sustain family members back at home. Despite Xoom's current position which has been in decline alongside shrinking market share, allowing it to expand in PayPal's existing virtual ecosystem and benefit from the company's technology should help Xoom recover while building PayPal a new revenue stream.

Venmo, on the other hand, has already paid off for PayPal. The digital peer-to-peer (P2P) payment system has shown strong and the company has already announced plans to expand the service to merchants in order to monetize the service further. In 2015 alone, Venmo has already processed over $5.00 billion dollars, and in the most recent reporting quarter the division reported approximately 200% year over year growth to $2.10 billion in payment volume. PayPal has announced that it plans to expand Venmo's service to merchants, allowing for a faster payment method even at the cost of its own business.

Challenges Ahead

Despite great potential in the coming year, PayPal is still faced with growing challenges. The company continues to face increased competition in the digital payments and one-touch payments sector as companies such as Apple, Google, and Square expand their own digital offerings. Apple Pay is slightly limited by restrictions on the service to iOS users, but Google and Square continue to compete directly with PayPal. Until now, PayPal's brand has helped the company maintain its lead in the industry, but it must continue to expand.

Venmo also faces expansion and monetization challenges, as so far it has been used mostly for P2P transactions, and it faces an uphill battle in convincing merchants and businesses to adopt the payment system, which involves heavy costs. For the foreseeable future, the problem will still be compounded by the continued dominance of credit card companies such as Visa and American Express and the fact that until now, Venmo did not offer companies a significant advantage in switching services.

The Fundamental View

Although only trading as a publicly listed company for nearly half a year, PayPal is already showing strong promise even though share prices have been largely unmoved. As it presently stands, the payment solutions provider is already valued at $45.29 billion, a sum that substantially outpaces industry peers. With a current price to earnings multiple of 32.36, the valuation could be considered a little rich, but considering the high growth potential of the business and integration of additional channels, is more akin to a technology company than a financial services entity.

However, unlike other technology firms, PayPal actually is actually consistently showing profit and moreover, reinvesting those revenues in expanding the core business, a move that is likely to translate to further gains down the road. From a balance sheet perspective, the company is looking very strong, especially after eliminating all debt while boasting assets of approximately $28 billion. With net operating and free cash flow steadily rising over the years and capital expenditures still flowing, PayPal is assuredly investing in the future and preparing the company for explosive revenue growth.

From both a value and income investor's perspective, PayPal is not an ideal candidate. For one, the company does not offer a dividend and second, despite its reasonable valuation considering its business model, it appears a little rich for value investors looking to capitalize on further upside. 2016 could prove a challenging year for ecommerce in particular especially if spending trends remain intact. While online payment solutions have received increased interest, unless PayPal can keep adding to its user base and growing annual spending from these users, explosive upside in share prices will remain elusive. Based on current strong fundamentals, a rise back towards $42.55 in the coming months is not unreasonable, especially if holiday spending has a strong showing. Taking into accounting fundamentals and the revenue growth outlook, shares between $45.00-50.00 by the end of the 1st half of 2016 is a healthy target.

Conclusion

In spite of challenges in continuing to build on its success, PayPal is poised to have a successful year in 2016. While the company has seen its profit growth decline over time, their focus on volume growth over profit expansion mirrors the strategy of several successful companies, namely Amazon. If the company can turn around Xoom and succeed in their plans for Venmo monetization, 2016 could show strong improvement for both top and bottom-line results, with share prices benefiting handedly.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.